By Steven Malanga.

Bankrupt Stockton heads to court on Monday to win approval for its plan to exit Chapter 9, but it still has not crafted an agreement with one major creditor, Franklin Advisers, which is being asked to take a gigantic haircut in the case. Instead, Franklin will argue that Stockton hasn’t done enough to cut its debts, especially its pension costs. If Franklin can’t persuade U.S. Bankruptcy Judge Christopher Klein to force Stockton and Calpers to come to some kind of deal reducing the city’s pension debts, municipal investors should start worrying  about supplying credit to cities with big pension liabilities, especially in California.

The Detroit case has already given some investors pause because pensioners are recovering far more in that case, based on the proposed plan of adjustment, than some creditors.  Although the money to bolster pensions in Detroit is coming from private sources and the state legislature, some creditors have argued that they are being forced to take big losses in order to save the city museum’s art collection, and that money from the sale of those assets as well as the legislative bailout shouldn’t just be coming to pensions.

Franklin is in even deeper trouble than Detroit’s unsecured creditors, if the judge allows the Stockton plan to stick. The financial firm, which holds some $35 million in Stockton debt in its municipal bond funds, would get just $94,000 as a settlement, or less than a penny on a dollar.

One justification for that very small recovery, according to this Stockton Record story, is that Franklin is a giant financial firm with $845 billion in assets and can absorb the losses. But of course the assets of a financial manager are not its own money, but that of its clients. And if debtors start basing their proposed rates of repayment in bankruptcy  on the size of a creditor’s assets, it’s worth remembering that Calpers has $280 billion in assets itself.

Stockton will presumably argue that employees have already taken a haircut when the city eliminated its health care plan for retirees. But Franklin argues that retirees still get 70 percent recovery thanks to the city’s plan to leave pensions untouched.

Stockton followed the path in bankruptcy charted by Vallejo, which refused to reduce pensions in part because of fears that Calpers would tie up the city for years in litigation. But Franklin is now following the same strategy, refusing to yield to a deal and aiming legal firepower at Stockton, prompting a city official to comment earlier this month that, “We’re fighting now with Franklin tooth and nail, night and day. It’s very expensive.”

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Originally posted at Public Sector Inc.